Idaho Opinion of Lehman Brothers
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The short answer was that Lehman was illiquid and lacked sufficient collateral to borrow enough from the Fed or to renew the repurchase agreement contracts (repos) to avert collapse. Surprisingly, just before filing for bankruptcy, Lehman was given investment-grade ratings by the big three independent rating agencies.
By 2008, Lehman had assets of $680 billion supported by only $22.5 billion of firm capital. From an equity position, its risky commercial real estate holdings were thirty times greater than capital. In such a highly leveraged structure, a three- to five-percent decline in real estate values would wipe out all capital.
Fifteen years ago, the world witnessed the largest commercial collapse in history. The financial giant Lehman Brothers filed for bankruptcy on Sept. 15, 2008, with $613 billion in debt, putting thousands of employees out of work and sending the already recessionary economy into a tailspin.
Lehman Brothers was leveraged at 30.7 to 1 at that point of time. Merrill Lynch was at 26.9 to 1. While leverage spruces up returns when times are good, it also causes problems when times are bad. In fact, hedge fund manager David Einhorn believed that if calculated properly, Lehman Brothers had a leverage of .
For those of you that are too young to remember, Dick Fuld was the CEO of Lehman Brothers who found himself at the epicenter of the 2008 global financial crisis. Having been part of the finance world when this disaster struck, Fuld, to me, is akin to one of those Disney villains who turns up in a sequel.
Like most of its investment-banking peers, it employed a highly leveraged business model that enabled the firm to maintain $691,063 million of assets on just $22,490 million of stockholders' equity (a leverage rate of 30.73) (Lehman 2007).
Leverage, we've been told repeatedly, went from about 12-to-1 in 2004 to 33-to-1 in 2008. (Leverage is the ratio of debt or assets to equity; at 33-to-1 leverage, a mere 3 percent drop in the value of a firm's assets can wipe out its equity.)